Trusts and trust banking

Author: | Published: 5 Jan 2004
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Although the concept of a trust exists under Japanese law, it differs from the equivalent common law concept. Most notably, in Japan there is no concept of equitable ownership and thus no separation of the legal and equitable ownership of trust assets. The differences have led to confusion, particularly in cases where practitioners have tried to apply common law principles to a Japanese trust or vice versa.

What is a Japanese trust and who can conduct trust banking in Japan?

The nature of a Japanese trust
In essence, a Japanese trust is a creature of contract and statute. The Trust Law (Shintaku-hou; Law 62 of 1922, as amended) defines a trust as an arrangement in which the owner of property rights transfers such rights to a third party on the understanding that the transferee will administer, manage and/or dispose of the property in accordance with specific guidelines established by the transferor.

A trust agreement is usually necessary to set up a Japanese trust (a trust can also be created by a will, but this is rare). The trust agreement must comply with the mandatory requirements of applicable statute including the Trust Law and the Trust Business Law (Shintakugyou-hou; Law 65 of 1922, as amended).

The concept of a trust was introduced into Japanese law from the common law about 100 years ago. But Japan was, and remains, a civil law country, and the mixture created by a common law concept in a civil law context has always been somewhat volatile. Professor Shinomiya, one of the leading commentators on Japanese trusts, described the concept as being "unique and isolated in the Japanese legal system, like a drop of oil floating on a pool of water". Scholars have been trying to explain the nature of the Japanese trust in a manner which would lead to consistency with the other parts of the Japanese legal system. So far, none of these explanations has found unanimous support.

Ownership of the trust assets
Most fundamentally, there is no concept of equitable ownership under Japanese law and thus no separation of legal and equitable ownership of trust assets. Under a Japanese trust, it is the trustee that is the sole owner of the trust assets and, similarly, the Japanese trustee is the true counterparty in any transactions conducted in the name of the trust. But the trustee's ownership is subject to certain restrictions imposed by the trust agreement and by statute. For example, the trustee should not benefit from the trust assets (Article 9 of the Trust Law), the trust assets do not belong to the trustee's personal estate (Article 15) and the trustee should not acquire any proprietary interest in the trust assets (Article 22).

Conversely, although the beneficiary is not, as a matter of Japanese law, the owner of the trust assets, the beneficiary does enjoy some quasi-ownership rights under the Trust Law. For example, the beneficiary can object to the attachment of the trust assets by a court in proceedings against the trustee (Article 16(2)), the beneficiary has a right to request the return of the trust assets upon the bankruptcy of the trustee (based on an interpretation of Article 16(2)), and the beneficiary can apply to the court to nullify a disposal of the trust assets made by the trustee in violation of the tenor and purport of the trust agreement (Article 31).

In many ways, the quasi-ownership rights of a beneficiary in Japan resemble those of a beneficiary under a common law trust. But, in Japan, the beneficiary's interest comprises statutory and contractual rights against the trustee and the trust assets. Japanese law does not recognize a beneficiary as being the owner (or an owner) of the trust assets. It is critical to keep this distinction in mind when analyzing ownership and other issues under a Japanese trust.

Perfection of the trust
For a beneficiary to enforce its quasi-ownership rights with respect to the trust assets, including the right of separation on bankruptcy of the trustee, the trust must be perfected as a matter of Japanese law. The rules for perfection vary depending on the nature of the asset, but in general:

  • for assets capable of registration (other than securities), the trust is perfected by notation of the trust in the appropriate register;
  • for securities, the trust is perfected by segregation by means of booking in a separate account and, where possible, physical separation from the proprietary assets and other trust assets of the trustee; and
  • for physical assets (other than assets that are capable of registration), the trust is perfected by actual or constructive delivery of possession of the assets to the trustee.

In addition to the requirements for perfection, the Trust Law requires that the trustee separates assets held pursuant to a particular trust from its proprietary assets and assets held in relation to other trusts. This additional separation requirement does not affect the quasi-ownership rights of the beneficiary, but does aim to make it easier for the beneficiary to identify the trust assets and to enforce its quasi-ownership rights if a dispute arises.

Contracting with trusts
As the trustee is regarded as the legal owner of the trust assets, third parties contract with the trustee as principal (and not as agent or representative of the trustor or the beneficiaries). This principle creates liability issues for the trustee.

Trustees and trust business
The Trust Law and the Trust Business Law contain limitations on who can act as trustee of a Japanese trust and what types of assets can be entrusted into a Japanese trust. Only trust banks licensed in Japan are authorized to conduct trust business and the classes of trust assets which they are authorized to accept are limited to money, securities, monetary claims, moveable property, real estate and fixtures thereon and surface and land lease rights.

Trust banks are unique among Japanese financial institutions in that they concurrently provide financial services (banking business) and asset management services (trust business). They also offer a variety of services ancillary to those two main areas. The trust business component focuses on money trusts, pension trusts, loan trusts, investment trusts (including real estate investment trusts), pecuniary trusts other than money trusts, securities trusts, monetary claims trusts and special purpose trusts set up in connection with the securitization of assets. The banking business component involves accepting deposits, lending and providing foreign exchange facilities.

Common investment trust structures
Two common types of trust used in the Japanese market for investment purposes are the specified money, or tokkin, trust and the designated money, or shiteitan, trust. The main difference between these two trust structures is who makes the decision on how and when to invest the trust assets. Under a tokkin trust, a registered investment adviser appointed by the trustor instructs the trustee regarding investment of the trust assets. Under a shiteitan trust the trustee makes such decisions itself in accordance with the general investment guidelines provided in the trust agreement.

 Tokkin trust

 Shiteitan trust

Trustee's liability and fiduciary duties

Trustee's liability to the trustor, beneficiaries and joint-trustees
Trustees of Japanese trusts are required to administer trust assets in accordance with the underlying trust agreement. The Trust Law expressly provides that in performing such duties, a trustee must act in accordance with the tenor and purport of the trust agreement and with the due care of a good manager.

If losses to the trust assets are suffered as a result of the trustee's mismanagement or disposal of the trust assets (including the creation of security interests over the trust assets) in violation of the tenor and purport of the trust agreement, the trustor, the beneficiaries and any joint-trustee of the trust have a statutory right to claim against the trustee for indemnification of such losses or restitution of the trust assets. Further, if the trustee disposes of trust assets in violation of the tenor and purport of the trust agreement, the beneficiaries may avoid such disposal as against even innocent counterparties or subsequent acquirers if, before the time of such disposal, the trust assets are registered or recorded as being held on trust (or if the trust assets are not capable of being registered or recorded, if such counterparty or subsequent acquirer knew or should have known that the disposition was in violation of the trust agreement).

Trustee's liability to transaction counterparties
As the owner of the trust assets and the true counterparty in any transactions conducted in the name of the trust, the trustee of a Japanese trust is personally liable for all obligations of the trust. Trustees typically take two steps to limit their personal exposure under transactions conducted in the name of a trust. Firstly, the transaction documentation will usually include a limited recourse clause, limiting the transaction counterparty's recourse against the proprietary assets of the trustee or the assets of other trusts held by the trustee. Secondly, the underlying trust agreement will usually contain an indemnity provision whereby the trustor agrees to indemnify the trustee against any costs incurred or losses suffered by the trustee in connection with the management of the trust.

The limited recourse language will not affect the transaction counterparty's right of recourse to the trust assets. But where limited recourse language is used, the transaction counterparty will only be able to look to the trust assets as the source for payment of the trustee's obligations. For this reason, transaction counterparties generally insist on regular reporting by the trustee with respect to the trust assets and require the inclusion of a negative pledge clause that prohibits or limits the trustee's ability to create security over the trust assets, or take any other action that may reduce the value of the trust assets.

Further, transaction counterparties often require that any provision limiting its recourse against the proprietary assets of the trustee does not apply in cases where: the trustee has acted in breach of the trust agreement or its agreement with such counterparty; there has been negligence or misconduct on the part of the trustee; or the trustee has failed to segregate the trust assets as required under Japanese law.

Investment adviser's ability to bind trustee

One topical issue in the Japanese market relates to tokkin trusts and the ability of an investment adviser to bind the trustee. Because the appointment of the investment adviser and the scope of the investment adviser's authority are established by contract, this issue has to be looked at on a case-by-case basis.

Transaction counterparties will often not be provided with a copy of the investment advisory agreement or the trust agreement. Consequently, to avoid any confusion regarding the ability of an investment adviser to bind the trustee, all counterparties entering into transactions with Japanese trusts through an investment adviser should ensure that the transaction documentation clarifies the scope of the investment adviser's authority and confirms that the trustee will be bound to act on the instructions of the investment adviser. The inclusion of such provisions will also clarify to whom the transaction counterparty has recourse in the case of default.

Trends in Japanese trust banking

Master trusts
In March 1999, the government promulgated a deregulation schedule as part of the so-called Big Bang initiative. In this schedule, the government stated that a "master trust is possible by using a re-trust scheme under a specified comprehensive trust contract (tokutei houkatsu shintaku)". The use of master trust by way of re-trust or co-trust has become increasingly common, particularly in connection with the combining of pension trust funds that is occurring as a consequence of consolidation within the Japanese trust banking market.

Market participants are finding that master trust structures allow them to transfer the operational management of the trust assets efficiently and smoothly without affecting existing client relationships. Master trust structures are also being used to increase efficiency by, for example, separating investment advisory services from custodian services. In this way trust banks are able to focus on those services where they have an established speciality and market presence.

Another area where master trusts are now often used is in the securitization market. Although initial establishment costs for master trust structures are higher than single-issue structures, once established a master trust structure gives originators quick access to the capital markets, thereby allowing them to take maximum advantage of favourable market conditions. The higher initial establishment costs can also be spread over future issues because the existing programme infrastructure will lower the cost of such future issues. Despite the clear advantages of master trust structures in securitization, — especially for originators wishing to regularly secure pools of receivables such as housing loan receivables, commercial real estate loan receivables, consumer finance receivables or auto loan receivables — their use is limited by the classes of assets that can form the basis of a trust under Japanese law.

Changes to the Law Concerning Investment Trusts and Investment Companies (the Investment Trust Law) in November 2000 paved the way for setting up real estate investment trusts in Japan (JReits). Since the first JReits were listed on the Tokyo Stock Exchange in September 2001, they have proved popular. All listed JReits are closed-end corporate type entities that can issue units (shares) and notes. JReit units have been offered in the Japanese, US and Euro markets. One of the main contributing factors to this popularity has been the favourable tax treatment granted to JReits; provided that at least 90% of the profits of the trust are distributed to investors, such distributions are deductible by the JReit when calculating its taxable income for Japanese corporate tax purposes.

As of mid-November 2003, there were eight JReits listed on the Tokyo Stock Exchange, with a combined asset value of more than ¥1 trillion ($9.2 billion) (

Investments in distressed debt (reorganization claims)
Trusts have also recently started appearing in the context of corporate reorganization proceedings (kaisha kousei tetsuzuki). As many distressed debt investors do not want to have to actively participate in corporate reorganization proceedings, reorganization claims (kousei saiken) are being placed in trust and the distressed debt investors are purchasing the beneficial certificates issued by the trustee. The trustee, as the owner of the reorganization claims, then directly participates in the reorganization proceedings and there is no need for the distressed debt investors to, for example, attend meetings of reorganization claim holders.

Looking forward

Reform projects
In late July 2003, a working group of the Financial System Council of Japan submitted a report to the Prime Minister's Office recommending major changes to Japan's trust laws and regulations. These changes focus on expanding the scope of the classes of trust assets that a trustee is authorized to accept as its business, and revising the trust business licensing system to provide for more flexibility and greater competition.

Expanding scope of trust assets
Only money, securities, monetary claims, moveable property, land and fixtures thereon, and surface and land lease rights are permitted classes of trust assets. The proposed revision to the Trust Business Law will provide that this restriction be lifted in full so that any property rights (including intellectual property rights and carbon emission rights) may form the basis of a trust.

Revising trust business licensing system
Under the current system, only banks licensed under the Law Concerning the Concurrent Undertaking of Trust Business by Financial Institutions (Kin'yuukikan no shintakugyoumu no ken'ei-tou ni kan-suru houritsu; Law 43 of 1943, as amended) are permitted to carry on trust business. The proposed new system will provide for greater flexibility and competition by setting up three new categories of trust business license. The minimum requirements for these three categories will vary depending on the type of trust business to be undertaken. This analysis will focus on whether the underlying trust is:

  • a passive administration-focused trust (iji-kanri-gata shintaku), where the trustee has no discretion regarding the investment/disposal of trust assets;
  • a securitization-focused trust (ryuudouka-gata shintaku), where the trust was set up in connection with the securitization of assets; or
  • an active administration-focused trust (un'you-kanri-gata shintaku), where the trustee can invest/dispose of trust assets at its discretion.

Although the actual minimum requirements for each of these three new categories are yet to be finalized, it is expected that the greater the discretion of the trustee, the stricter the requirements will be.

It is expected that the Financial Services Agency will table the proposed revisions in the Japanese Diet early in 2004.

Future business opportunities and challenges
The reforms will provide both business opportunities and challenges. The expansion of trust asset classes will lead to an increase in the number of trust-based financial products available to consumers, thereby offering new business opportunities to both existing and new market participants. For example, intellectual property trusts will increase the options available to the many Japanese companies holding large intellectual property portfolios to leverage such assets to raise funds.

The proposed revisions to the trust business licensing system will also offer a broader range of new entities the opportunity to participate in the market and compete directly with the existing trust banks. This will create significant challenges for existing trust banks striving to maintain profitability levels as the increase in competition may drive down fees and margins. Also, the ability of large corporations to set up captive trust companies to manage group pension funds may reduce the need of such corporations to rely on the services provided by trust banks under the current regime.

Author biography

Shinji Toyohara

Tokyo Aoyama Aoki Law Office

Shinji Toyohara is a partner of Tokyo Aoyama Aoki Law Office and divides his practice between transactional work and regulatory/structured products work. His transactional practice centres on project finance, PFI and DIP financing. His regulatory/financial products practice focuses on advice concerning banking, trusts, insurance and derivatives.

Toyohara is familiar with Japan's financial markets, and represents foreign banks, securities companies, and insurance companies in relation to the Japanese legal and regulatory aspects of a range of structured transactions. In addition, he works with a wide range of Japanese banks, trust banks, securities companies, fund managers and insurance companies.

Toyohara is admitted to practice law in Japan and New York. He received an LLB from the University of Tokyo in 1984 and an LLM from the Columbia Law School in 1998. He is a member of the Tokyo Bar Association.

Jeremy Pitts

Baker & McKenzie

Jeremy Pitts is a partner of Baker & McKenzie and focuses his practice on financial regulation, product development and structured financial transactions in Japan. He has extensive experience acting for foreign financial institutions, and has a comprehensive knowledge of Japanese financial markets and practices. Working closely with a team of specialized Japanese lawyers, he has been actively involved in assisting foreign financial institutions with regulatory matters in Japan and with the development of new products for the market.

Pitts is the leader of Baker & McKenzie's Asia Pacific banking and finance practice group. He is also managing partner of the firm's Tokyo Office. He was named a leading banking and finance lawyer for Japan by both Global Counsel 3000 and Asia Pacific Legal 500 (2003).

Pitts is qualified in New South Wales. He is also admitted as a solicitor in England and is registered as a foreign lawyer in Japan.

Gavin Raftery

Tokyo Aoyama Aoki Law Office - Baker & McKenzie

Gavin Raftery is a foreign associate with Tokyo Aoyama Aoki Law Office - Baker & McKenzie and focuses his practice in the areas of loans and credit facilities, JBIC and NEXI supported financial transactions, derivatives, securitization and other structured financial transactions, acquisition finance, financial regulation and product development. He is fluent in Japanese and specializes in assisting clients in the banking, trust banking, insurance, and securities industries.

Raftery is qualified in New South Wales and is admitted in England and Wales. He is not admitted in Japan.

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